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The “Termination for Convenience” Clause: A Closer Look

—RMZ

More than ever before, your business may find itself entering into contracts which contain a “Termination for Convenience” (or “TFC”) clause. Whether you are negotiating a contract where such a clause is proposed, seeking to enforce such a clause, or resisting the effect of such a clause, it is important to understand just what these clauses can (and cannot) accomplish.

Termination for convenience clauses can be found in most any type of contract: the larger the amounts at stake, the longer the duration of the contract, and the more market power one party contracts for the sale of goods (especially large quantities over a long period of time); the more likely the contract is to contain a TFC clause.

In the United States, there is no national standard or uniformly applicable rule for the interpretation of TFC clauses, each state may apply its own law — or, more specifically, the law of the state the parties consent to apply governs. However, TFC clauses generally cause confusion for businesses because of their name: such clauses, misleadingly do NOT generally allow one party to simply terminate a contract for simple “convenience”.

A short history lesson of the TFC clause might help understand its true purpose better. TFC clauses first appeared in major procurement contracts awarded by the federal government. The first so called “TFC” clauses were inserted to protect the government from being saddled with a large, fixed-price contract that changed circumstances – even if not spelled out specifically in the contract – no longer warranted. For example, a contract to build 500 P-51 fighters at the height of World War II could be “terminated” once hostilities ceased. Since then, TFC clauses have found their way into private agreements, and courts have tended to apply one of two tests to determine whether a termination for convenience is appropriate: the “changed circumstances” test, where some major change makes the termination reasonable in light of a new reality, and the “bad faith / abuse of discretion” where a termination is viewed in light of the terminating party’s obligation to contract in “good faith” with a party. Cancelling an existing contract to get a better price or terms from another vendor is usually not considered to be done in good faith.

The bottom line is that courts are generally reluctant to enforce a term that allows one party to cancel a contract at its whim, for no good reason at all; such a clause tends to make the rest of the contract – in term, price, and most other essentials, illusory. Properly understood, a TFC clause gives one (or both) parties to a contract the ability to opt-out of future obligations where some legitimately changed circumstance: the cessation of a related project, a major shift in strategic direction, or a notable market disruption or macroeconomic force changes the landscape in a way the parties did not foresee – at least enough to include specifically in the contract. A properly drafted and enforced “Termination for Convenience” clause allows a welcome flexibility to businesses otherwise fearful of sizable commitments of resources, but not carte blanche to cancel contracts entered into in good faith.

Recently a Roberts McGivney Zagotta client serving as a project management vendor to a major energy company was served notice that its contracts, which had nearly a year left to run, were being terminated at the energy company’s “convenience.” Our investigation revealed that company management had decided to award a new project management contractor to a larger (and presumably cheaper) single-source vendor. Most of the energy company’s vendors either terminated their contracts without complaint, or worked out sub-contracting arrangements with the new vendor – at sharply reduced rates. Careful analysis of our client’s contracts under the applicable state law revealed that the Termination for Convenience clause would not apply in such a circumstance in that state. After we shared our analysis with the energy company, our client’s contract was reinstated, resulting in a half-million dollars in additional revenue.

The above should be considered a general introduction, and not as specific legal advice. If you would like to know more about Termination for Convenience clauses in your business contracts please contact RMZ.